Canada Mortgage Housing Corporation (CMHC), estimates that less than 1% of mortgage credit outstanding today is funded through MIC’s (private lenders). Let’s assume that it is 0.5% of the total residential mortgage debt in Canada ($1.49 trillion as per the Bank of Canada). This would equate to $7.5 Billion of private mortgages in Canada.
This week I will answer four questions on private mortgages:
- What are private mortgages?
- Why do people seek private mortgages?
- What are the risks to the borrower?
- What are the rates and costs?
What are private mortgages?
Simply put, it’s a mortgage loan that is NOT provided by regulated financial institution. A typical mortgage loan comes from a bank, mortgage Lender, or credit union that are regulated by OSFI or FSCO. Although the financial institution is not regulated, the practice of private lending is regulated through the provincial regulator (FSCO in Ontario).
The private lender could be either of the following:
- Wealthy individuals looking to invest their money for a return. Often times, they are drawn by the diversification and alternative to investing in the stock market.
- Syndicated investors. These are individuals who pool their money together (syndicate) and invest it in mortgage loans.
- Mortgage Investment Corporations (MICs) – they have the “feel” of a lending institution but are fully unregulated. CMHC estimates there are between 200-300 MIC’s in Canada. In 1973, the federal government created laws to enable MIC’s to operate to increase the flow of mortgage funds and provide a channel for small investors to participate in the market.
Bottom line, a regular bank mortgage and a private mortgage are the same thing – a loan secured by the property. The parties involved in a private mortgage are:
- Mortgagor - borrowing the money
- Broker – arranging the transaction
- Lender / investor – providing the funds
- Lawyer for Borrower – fulfills the instructions from the Lender/investor
- Lawyer for Lender/investor – represents the investor
- Appraiser – independent contractor hired on behalf of the Lender / investor
Why do people seek private mortgages?
Banks and mortgage lenders have the lowest cost of funds and can offer mortgages with the lowest rates. However, when someone is not able to meet their approval qualifications they have a problem. In most cases, people enter into a private mortgage is because it resolves a problem. In certain cases, people prefer private mortgages over a financial institution mortgage.
Here are some reasons:
- Want to buy a property that a bank/lender won’t finance. Examples, could be micro-condos, log cabins, mobile, etc.
- The income to pay the mortgage is not traditional employment income. An example might be capital gains from a stock portfolio.
- Credit problems, either from negligence, divorce issues, etc.
- Quick closing is urgently needed. Perhaps the bank pulled the mortgage funding last minute and a mortgage is needed to close the purchase.
- Foreclosure situations. The bank is threatening to foreclose but more time is needed.
- Construction project financing flexibility. Construction loans from banks usually have many covenants and conditions for drawing the funds during the project.
- Commercial loans.
- Equity take outs (ETO). Financial institutions have limits on the equity take out amounts or reason. The ETO can be used for any reason, such as supporting a family owned business.
- Foreign investors and Non-residents – The programs available for foreign buyers are very selective and limited.
- CRA back tax issues. Traditional lenders draw a hard line on back taxes owing.
- Property taxes are in arrears.
- Short term working capital. Perhaps money is tight for a pending renovation but will be cleared up once the property is sold.
- Want to leave first mortgage alone. A refinance might result in loss of default insurance, high penalties.
- The first mortgage has a “sale only clause”. This means the lender won’t let you refinance unless you sell the property.
- Customizable solutions, such as open terms, interest only payments, or a longer amortization period.
What are the risks to the borrower?
First, if a borrower misses a mortgage payment, then the bank/lender will charge an NSF fee and perhaps start the power of sale process. In general, a bank/lender prefers not to go through the process if it can be rectified. It really depends on the circumstances of the individual. Was it due to negligence or was it due to a lost job? A private lender, especially an individual, may also try to be understanding or they may be hard lined and enact a power of sale action very quickly.
Second, a borrower might potentially be “sharked” by an unscrupulous greedy lender or broker. Depending on the desperation level, the rate or fees offered to a borrower could be unusually high. Finding a trustworthy and experienced broker is imperative to helping you find the best deal.
Third, much like other traditional bank/lender mortgages, it’s important to read the small print and know what you’re getting into. What are the pre-payment privileges? What are the penalties for breaking the mortgage early?
What are the rates and costs?
Interest rates on private mortgage are higher than a bank/lender mortgage. How much higher depends on the risk for the investor. The higher the risk, the higher the rate. For example, a third position mortgage with a high loan-to-value ratio on a poor property location will have a high rate. Typically, rates are about 7-12% range but depend on the term and other fees too. The other costs that the borrower will have to incur are:
- Lender fees – upfront fee paid to the private investor
- Brokerage fees – the income for the mortgage broker
- Legal costs – costs to register the mortgage in land titles office
- Appraisal – cost paid to an independent appraiser to value the property
There are many reasons why people need to borrow money. Using a house as collateral for a loan will produce the lowest rates because it’s a tangible immovable asset – called a mortgage. When financial institutions won’t lend to a borrower for whatever reason (i.e. bad credit) there is still a market of lenders (aka private investors) whom will. A well respected and trustworthy mortgage broker can help someone in need of funds secured by a property – whether to buy a property, refinance, etc. – where a financial institution cannot.
About the Author:
Ian Mucignat, CFA, is an independent mortgage agent at TMG The Mortgage Group. He graduated from Wilfrid Laurier University with a Bachelor of Business Administration, minoring in Economics and is a CFA Charterholder. Ian has worked in the mortgage industry since 2000 at lenders, banks, and brokerages. If you are purchasing, renewing, or refinancing your mortgage don’t hesitate to contact Ian directly for a free consultation.